Am I Diversified?

When it comes to investing we are taught to have a “diversified” portfolio.  This concept grew in importance back when companies gave employees company stock in their pensions. Unfortunately, not every company continues to thrive and if the stock loses value there can be little left for retirement.  Thus the concept of portfolio diversification gained traction as a simple way to keep from having “all your eggs in one basket.”

Statutory Guidance

As a fiduciary for several ERISA based retirement plans (i.e. 401(k)’s), portfolio recommendations are guided by the Uniform Prudent Investor Act (UPIA).  Enacted in its current form in 1995, the UPIA places a primary duty of suitability, requiring investments be suitable for the purposes of the trust.  Section 3 specifically creates the Duty to Diversify, which is why investment options in a retirement plan are likely a series of mutual funds which by their nature are diversified.

Studies have shown that a portfolio of just a handful of stocks creates diversification benefits.  This is why it is a good idea to select multiple funds or a target date fund in a retirement plan. Further, the past decade has seen the rise of passive index funds, where a single fund will mimic an index hundreds of stocks like the S&P 500 or the Russell 2000.

Multiple Baskets

But even if your proverbial eggs are spread amongst multiple baskets further diversification may be beneficial. In investing parlance, this means looking for asset classes that are “non-correlated” to stocks that move differently over time.  In retirement plans this means a mixture of both stocks and bonds, with a higher concentration of stocks (which are considered riskier) earlier in life, and shifting to more bonds (considered safer) as one gets closer to retirement.  This is exactly how the target-date funds in a retirement plan work.

Alternative Investments

Todays retirement plans and investment accounts can hold a broader array of asset classes than ever.  These assets include precious metals, minerals, real estate, currencies, commodities, mortgages, private equity and even Bitcoin.  Through mutual funds and ETFs, all of these investments are possible without owning or possessing the physical asset.

Physical assets also provide further diversification and the benefit of tactile enjoyment.  The most common is owning a home, which for many is the largest asset on their balance sheet.

Wealthier investors also use collectibles such as art, jewelry and classic cars as investments to diversify a portfolio.  Social media in particular has significantly expanded the market for collectibles, minting millionaires from collections of everything from sneakers to Pokemon cards and video games.